# MIS. DIT (INTERNATIONAL TAXATION), MUMBAI ,_ v. MIS. MORGAN STANLEY & CO

- **Citation:** [2007] 8 S.C.R. 52
- **Court:** Supreme Court of India
- **Decided:** 2007-07-09
- **Case number:** Civil Appeal No. 2914 of2007
- **Bench:** Dr. Arijit Pasa Yat, S.H. Kapadia
- **Source:** https://unisonlegal.in/judgment/supreme-court-of-india/mis-dit-international-taxation-mumbai-v-mis-morgan-stanley-co-23163
- **Pages:** 34

## Headnote

Income Tax Act, 1961:
c
Section 92-lnterniitional transaction-Computation of income fromArm's length price-Relevance of-Methods to determine-Authority for
Advanced Ruling (AAR)-Permanant Establishment (PE)-Projits attributable
to-Morgan Stanley & Co. (MSC) has three main lines of business, namely,
securities investments management, investment banking and credit servicesMSCO had set up a captive Business Process Out sourcing (BPO) in India,
D namely, Morgan Stanley Advantage Services (MSAS)-MSCo accordingly
made an application seeking an Advance Ruling as to whether it was having
\.
a permanent Establishment (PE) in India and, if so, the amount of Income
attributable to such PE-AAR held that MSCo could not be regarded as
having a fixed place of business PE; that MSAS could not be regarded as
E an agency PE; and that the applicant would be regarded, as having a PE
in India only if it were to send some of its employees to India as stewards
or as deputationists in the employment of MSAS-Validity of-Held: AAR was
right in ruling that MSAS would be a Service PE in India, though only on
account of the services to be performed by the deputationists deployed by
F
MSCo and not on account of stewardship activities-The transactional net
margin method (TNMM) was appropriate for determination of arm's length
price in respect of transaction between MSCo and MSAS-In the case of
MSCo and MSAS, the remuneration was rightly fixed at a margin of 29%
worked out on the basis of Cost plus Method_:. Therefore, the Department has
to determine income, expense or cost allocations having regard to arm's
G length prices to decide the applicability of the transfer pricing regulationsEconomic nexus is an important aspect of the principle of Attribution of
(
Profits-Income Tax Rules, 1962 Rr_ JOA to JOE-Double Tax Avoidance
'
Agreement, Articles 5 and 7.
\.
·'
;
if
52
,
DIT (INTERNATIONAL TAXATION), MUMBAI v. MORGAN STANLEY II< CO.
53
---..,
The respondent-company is one of the world's largest diversifying A
financial services companies. It has three main lines of business, namely,
securities investment managements investment banking and credit services.
Morgan Stanley and Company ('MSCo') is an investment bank engaged in
the business of providing financial advisory services, corporate lending and
securities underwritting.
B
One of the group companies of the respondent-company, namely, Morgan
Stanley Advantages Services Pvt. Ltd. ('MSAS') entered into an agreement
for providing certain support services to MSCo. MSCo accordingly made an
application seeking an Advance Ruling as to whether it was having a
Permanent Establishment (PE) in India under Article 5(1) of the Double Tax
Avoidance Agreement ('OT AA') on account of the services rendered by MSAS c
under the Services Agreement entered into by MSAS with the applicant and,
if so, the amount of income attributable to such PE.
The Authority for Advance Ruling(' AAR') held that the applicant could
not be regarded as having a fixed place of business PE under Article 5(1) of D
the DT AA; that MSAS could not be regarded as an agency PE under Article
5(4) of the DTAA; and that the applicant would be regarded as having a PE in
India under Article 5(2) (1) only if it were to send some of its employees to
India as stewards or as deputationists in the employment of MSAS. Hence
the appeal.
E
Allowing the appeal in part, the Court
HELD: 1. The question which arises for consideration in the present
case is the nature of activities performed by stewards and deputationists
deployed by Morgan Stanley and Company ('MSCo') to work in India as
F
·r
employees of Morgan Stanley Advantages Services Pvt Ltd. ('MSAS'). Under
Article 5(2)(1) of the Double Tax Avoida11ce Agreement ('DTAA') furnishing
of services through the fixed place in India can constitute a Permanent
Establishment (PE). The Authority for Advance Ruling ('AAR') in the
impugned ruling has held that the stewards and deputationists are proposed
to be sent by MSCo fro

## Text

_Characters 0–39,950 of 79,927. This is a partial read: ask again with offset=39950 for what follows._

1
-+-
A
MIS. DIT (INTERNATIONAL TAXATION), MUMBAI
,_..-
v.
MIS. MORGAN STANLEY & CO.
JULY 9, 2007
B
[DR. ARIJIT PASA YAT AND S.H. KAPADIA, JJ.]
Income Tax Act, 1961:
c
Section 92-lnterniitional transaction-Computation of income fromArm's length price-Relevance of-Methods to determine-Authority for
Advanced Ruling (AAR)-Permanant Establishment (PE)-Projits attributable
to-Morgan Stanley & Co. (MSC) has three main lines of business, namely,
securities investments management, investment banking and credit servicesMSCO had set up a captive Business Process Out sourcing (BPO) in India,
D namely, Morgan Stanley Advantage Services (MSAS)-MSCo accordingly
made an application seeking an Advance Ruling as to whether it was having
\.
a permanent Establishment (PE) in India and, if so, the amount of Income
attributable to such PE-AAR held that MSCo could not be regarded as
having a fixed place of business PE; that MSAS could not be regarded as
E an agency PE; and that the applicant would be regarded, as having a PE
in India only if it were to send some of its employees to India as stewards
or as deputationists in the employment of MSAS-Validity of-Held: AAR was
right in ruling that MSAS would be a Service PE in India, though only on
account of the services to be performed by the deputationists deployed by
F
MSCo and not on account of stewardship activities-The transactional net
margin method (TNMM) was appropriate for determination of arm's length
price in respect of transaction between MSCo and MSAS-In the case of
MSCo and MSAS, the remuneration was rightly fixed at a margin of 29%
worked out on the basis of Cost plus Method_:. Therefore, the Department has
to determine income, expense or cost allocations having regard to arm's
G length prices to decide the applicability of the transfer pricing regulationsEconomic nexus is an important aspect of the principle of Attribution of
(
Profits-Income Tax Rules, 1962 Rr_ JOA to JOE-Double Tax Avoidance
'
Agreement, Articles 5 and 7.
\.
·'
;
if
52
,
DIT (INTERNATIONAL TAXATION), MUMBAI v. MORGAN STANLEY II< CO.
53
---..,
The respondent-company is one of the world's largest diversifying A
financial services companies. It has three main lines of business, namely,
securities investment managements investment banking and credit services.
Morgan Stanley and Company ('MSCo') is an investment bank engaged in
the business of providing financial advisory services, corporate lending and
securities underwritting.
B
One of the group companies of the respondent-company, namely, Morgan
Stanley Advantages Services Pvt. Ltd. ('MSAS') entered into an agreement
for providing certain support services to MSCo. MSCo accordingly made an
application seeking an Advance Ruling as to whether it was having a
Permanent Establishment (PE) in India under Article 5(1) of the Double Tax
Avoidance Agreement ('OT AA') on account of the services rendered by MSAS c
under the Services Agreement entered into by MSAS with the applicant and,
if so, the amount of income attributable to such PE.
The Authority for Advance Ruling(' AAR') held that the applicant could
not be regarded as having a fixed place of business PE under Article 5(1) of D
the DT AA; that MSAS could not be regarded as an agency PE under Article
5(4) of the DTAA; and that the applicant would be regarded as having a PE in
India under Article 5(2) (1) only if it were to send some of its employees to
India as stewards or as deputationists in the employment of MSAS. Hence
the appeal.
E
Allowing the appeal in part, the Court
HELD: 1. The question which arises for consideration in the present
case is the nature of activities performed by stewards and deputationists
deployed by Morgan Stanley and Company ('MSCo') to work in India as
F
·r
employees of Morgan Stanley Advantages Services Pvt Ltd. ('MSAS'). Under
Article 5(2)(1) of the Double Tax Avoida11ce Agreement ('DTAA') furnishing
of services through the fixed place in India can constitute a Permanent
Establishment (PE). The Authority for Advance Ruling ('AAR') in the
impugned ruling has held that the stewards and deputationists are proposed
to be sent by MSCo from U.S. According to the AAR there is a Oow of service G
from the MSCo to the MSAS when the former deputes its own employees to
work in India in MSAS. Therefore, according to the AAR the service
J
I
Agreement between MSCo and MSAS would fall under Article 5(2)(1) and
consequently the transfer pricing regulation would apply for evaluating tlle
charges payable by MSCo to MSAS in India for such service contract This
H
)
_ __,__
54
SUPREME COURT REPORTS
(2007) 8 S.C.R.
A ruling has been challenged by the applicant. (Para 13) (67-B-D)
;.--
2. Article 5(2) of the DT AA applies in cases where the multinational
.enterprise furnishes services within India and those services are furnished
through its employees. In the present case this Court is concerned with two
activities, namely, stewardship activities and the work to be performed by
B deputationists in India as employees of MSAS. A customer like the MSCo
which has world wide operations is entitled to insist on quality control and
confidentiality from the service provider. For example in the case of software
PE a server stores the data which may require confidentiality. A service
provider may also be required to act according to the quality control
c
specifications imposed by its customer. It may be required to maintain
confidentiality. Stepwardship activities involve briefing of the MSAS staff to
-ensure that the output meets the requirements of the MSCo. These activities
include monitoring of the outsourcing operations at MSAS. The object is.to
protect the interest of the MSCo. These stewards are not involved in day-today management or in any specific services to be undertaken by MSAS. The
D stewardship activity is basically to protect the interest of the customer. In the
present case, the MSAS is a service PE. It is in a sense a service provider. A
customer is entitled to protect its interest both in terms of confidentiality
and in terms of quality control. In such a case it cann->t be said thatMSCo
has been rendering the services to MSAS. MSCo is merely protecting its
own interests in the competitive world by ensuring the quality and
E confidentiality of MSAS services. It is not possible to agree with the ruling
of the AAR that the stewardship activity would fall under Article 5(2)(1). To
this extent there is merit in the civil appeal filed by the appellant (MSCo) and
accordingly the appeal to that extent stands partly allowed.
(Para 14) (67-D-H; 68-A-B(
F
3. A regards the question of deputation, an employee of MSCo when
· deputed to MSAS does not become an employee ofMSAS. A deputationist has
a lien on his employment with MSCo. As long as the lien remains with the
MSCo, the said company retains control over the deputationist's terms and
employment.The concept of a service PE finds place in the U.N. Convention.
G It is constituted if the multinational enterprise renders services through its
employees in India provided the services are rendered for a specified period.
In this case, it extends to two years on the request of the MSAS. It is important
to note that where the activities of the multinational enterprise entails it being
\
responsible for the work of deputationists and the employees continue to be
\
on the payroll of the multinational enterprise, a service PE can emerge.
H Applying the above tests to the facts of this case it is found that on request/
DIT (INTERNATIONAL TAXATION). MUMBAI v. MORGAN STANLEY & co.
SS
requisition from MSAS the applicant deputes its staff. The request comes A
from MSAS depending upon its requirement. Generally, occasions do arise
when the MSAS needs the exercise of the staff of MSCo. In such
circumstances, generally, MSAS makes a request to MSCo. A deputationist
under such circumstances is expected to be experienced in baking and finance.
On completion of his tenure he is repatriated to his parent job. He retains. B
his lien when he comes to India. He lends his experience to MSAS in India as
an employee ofMSCo as he retains his lien and in that sense there is a service
PE (MSAS) under Article 5(2)(1). There is no infirmity in the ruling of the
AAR on this aspect. In the above situation, MSCo is rendering services
through its employees to MSAS. Therefore, the Department is right in its
contention that under the above situation there exists a Service PE in India C
(MSAS). Accordingly, the civil appeal filed by the Department stands partly
allowed. (Para 15( (68-B-F(
4. The taxpayer is required to compute arm's length price for a
transaction(s) using one of the five methods stipulated in the Income Tax Rules.
Rule IOC(I) of the Income Tax Rule, 1962 defines the most appropriate method D
as the method which is best suited to the facts and circumstances of each
particular international transaction. As per Rule IOC(2) the most appropriate
. method has to be selected having regard to a number of factors which are
enumerated therein. The arm's length price has to be computed by the
application of methods mentioned in Section 92(C)(l) of the Income Tax Act, E
1961. (Para 18( (69-F-G(
5.1. The inethods to determine arm's length price in relation to
international transaction, namely, Comparable Uncontrolled Price method,
Regular Price Method, Cost Plus Method, Profit Split Method, Transactional
Net Margin Method (TNMM) etc. are mentioned in Section 92C read with F
Rule 108. The most appropriate method has to be applied for computation of
the arm's length price. It will depend on the facts and circumstances of each
particular international transaction (Rule lOC). (Para 27( (80-H; 81-A-B}
5.2. It may be noted that on the question of appropriateness of the TNMM,
the AAR did not give its ruling on the transfer pricing as proceedings had , G
commenced before the tax officer before MSCo could seek the ruling. However,
after the impugned ruling, Transfer Pricing Officer· and the Assessing
Officer have found the said method (TNMM) to be appropriate. Apart from
the order passed by the Assessing Officer and the Transfer Pricing Officer,
the said method (TNMM) is the appropriate method in the case of Service PE H
56
SUPREME COURT REPORTS
(2007] 8 S.C.R.
A as TNMM apportions the total operation profit arising from the transaction
on the basis of sales, cost, assets, etc. (Para 28) (81-D-EJ
5.3. As regards determination of profits attributable to a PE in .India
(MS~S) is concerned; on the basis of arm's length principle Article 7(2) of
the DTAA is quoted. According to the AAR where there is an international
B transaction under which a non-resident compensates a PE_ at arm's length
price, no further profits would be attributable in India. (Para 291 (81-Fl
6. Article 7 of the U.N. Model Convention inter alia provides that only
that portion of business profits is taxable in the source country which is
attributable to the PE. It specifies how such business should be ascertained.
C · Under the said Article, a PE is treated as if it is an independent enterprise
(profit centre) dehors the head office and which deals with the head office at
arm's length. Therefore, its profits are determined on the basis as if it is an
independent enterprises. The profits of the PE are determined on the basis of
what an independent enterprise under similar circumstances might be expected
'
D to derive on its own. Article 7(2) of the U.N. Model Convention advocates the
arm's length approach for attribution of profits to a PE. (Para 31)
7. The object behind enactment of transfer pricing regulations is to
prevent shifting of profits outside India. Under Article 7(2) not all profits of
MSCo would be taxable in India but only those which have economic nexus
E with PE in India. A foreign enterprise is liable to be taxed in India on so much
of its business profit as is attributable to the PE in India. The quantum of
taxable income is to be determined in accordance with the provisions of the
Income Tax Act All provision of the Income Tax Act are applicable, including
provision relating to depreciation, investment losses, deductible expenses,
F carry-forward and set-off losses etc. However, deviations are made by DT AA
in cases of royalty, interest etc. Such deviations are also made under the
Income Tax Act (for example: Sections 4488, 448BA etc.) Under the
impugned ruling delivered by the AAR remuneration to MSAS was justified
by a transfer pricing analysis and, therefore, no further income could be
attributed to the PE (MSAS). In other words, the said ruling equates an arm's
G length analysis (ALA) with attribution of profits. It holds that once a transfer
pricing analysis is undertaken, there is no further need to attribute profits
to a PE. The impugned ruling is correct in principle insofar as an associated
enterprise, that also constitutes a PE, has been remunerated on an arm's
length basis taking into account all the risk-taking functions of the
H enterprise. In such cases, nothing further would be left to be attributed to the
+
DIT (INTERNATIONAL TAXATION). MUMBAI v. MORGAN STANLEY & CO.
57
-
--.,:
PE. The situation would be different if transfer pricing analysis does not A
adequately reflect the functions performed and the risks assumed by the
enterprise. In such ~ situation, there would be a need to attribute profits to
the PE for those functions/risks that have not been considered. Therefore, in:
each case the data placed by the taxpayer has to be examined as to whether
the transfer pricing analysis placed by the taxpayer is exhaustive of B
attribution of profits and that would depend on the functional and factual
analysis to be undertaken in each case. Lastly, it may be added that taxing
corporates on the basis of the concept of Economic Nexus is an important
feature of Attributable Profits (Profits attributable to the PE).
(Pa.ra 32) (84-D-FJ c
8. AAR was right in ruling that MSAS would be a Service PE in India
under Article 5(2)(1), though only on account of the services to be performed
by the deputationists deployed by MSCo and not on account of stewardship
activities. As regards income attributable to the PE (MSAS) it is held that·
the Transactional Net Margin Method was the appropriate method for D
determination of the arm's length price in respect of transaction between
MSCo and MSAS. It is accepted as correct the computation of the
remuneration based on cost plus mark-up method worked out at 29% on the
operating costs of MSAS. This position is also accepted by the Assessing
Officer and also by the transfer pricing officer. As regards attribution of
further profits to the PE of MSCo where the transaction between the two are E
held to be at arm's length, it is held that the ruling is correct in principle
provided that an associated enterprise (that also constitutes a PE) is
remunerated on arm's length basis taking into account all the risk-taking
functions of the multinational enterprise. In such a case nothing further would
be left to attribute to the PE. The situation would be different ifthe transfer F
pricing analysis does not adequately reflect the.functions performed and the
risks assumed by the enterprise. In such a case, there would be need to
attribute profits to the PE for those-functions/risks that have not been
considered. The entire ultimately is to ascertain whether the service charges
payable or paid to the service provider (MSAS in this case) fully represents
the value of the profit attributable to his service. In this connection, the G
Department has also to examine whether the PE has obtained the services
from the multinational enterprise at lower than the arm's length cost.
)
Therefore, the Department has to determine income, expense or cost
allocations having regard to arm's length prices to decide the applicability of
the transfer pricing regulations. (Para 33) [84-G-H; 84-A-EJ
H
...
58
SUPREME COURT REPORTS
[2007] 8 S.C.R.
"'
A
9. Economic nexus is an important aspect of the principle of Attribution
>-
of Profits [Para 34)
CIVIL APPELLATE JURISDICTION: Civil Appeal No. 2914 of2007.
From the Judgment and Order dated 13.2.2006 of the Authority for
B Advance Rulings (Income-Tax), New Delhi in A.A.R. No. 661/2005.
WITH
C.A. No. 2915 of2007.
c
Mohan Parasaran, A.S.G., Dr. R.G. Padia, Sr. Adv., Ranbir Chandra, D.K.
Singh, Pradeep Shukla, Arijit Prasad and B. V. Balaram Das for the Appellant.
Soli J. Sorabjee, S. Ganesh, Sr. Adv., Nishit Desai, Reena Bagga, Pritesh
Kapoor, Bijal, Meenakshi, Jeetendra and Jay Savla for the Respondent.
D
The Judgment of the Court was delivered by
KAPADIA, J. I. Leave granted.
2. In these civil appeals we are concerned with the articles in Double
Tax Avoidance Agreement ("DTAA'') between India and United States which
E have implication on transfer pricing legislation. The said Treaty either
advocates application of arm's length principle or provides a mechanism for
avoiding double taxation on income.
3. Morgan Stanley Group (MS Group) is one of the world's fargest
diversifying financial services companies. It is a world wide leader in investment
F
banking and it is ranked amongst the top institutions in merger and
-f
acquisitions, underwriting of equity and equity and related transactions. It
has a major presence in major securities market, with traders in numerous
countries around the world offering a unique distribution of products. It has
,.
three main lines of business, namely securities investment management and
G
investment banking and credit services. Morgan Stanley and Company (for
short, 'MSCo') is an investment bank engaged in the business of providing
financial advisory services, corporate lending and securities underwriting.
One of the group companies of Morgan Stanley, Morgan Stanley Advantages
\.-
Services Pvt. Ltd. (for short, 'MSAS') entered into an agreement for providing
certain support services to MSCo. MSCo outsourced some of its activities to
H MSAS. The said MSAS was set up to support the main office functions in
/
DIT (INTERNATIONAL TAXATION), MUMBAI v. MORGAN STANLEY & CO. (KAPADIA, J.]
59
equity and fixed income research, account reconciliation and providing IT A
enabled services such as back office operation, data processing and support
centre to MSCo.
4. On 19.5.2005 MSCo (Applicant) filed its advance ruling application in
Form 34-C inviting its advance ruling on the points enumerated hereinbelow.
The basic question relating to the transaction between the applicant and B
MSAS on which advance ruling was sought was two fold namely, whether
the applicant was having a PE in India under Article 5(1) of the OT AA on
account of the services rendered by MSAS under the Services Agreement
dated April 14, 2005 entered into by MSAS with the applicant and if so, the
amount of income attributable to such PE.
5. By the impugned ruling delivered on 13.2.2006 by the Authority for
Advance Ruling (for short, 'AAR') it was held, inter alia, that the applicant
cannot be regarded as having a fixed place of business PE under Article 5(1)
of the OT AA; that MSAS cannot be regarded as an agency PE under Article
c
5(4) of the DTAA; that the applicant would be regarded as having a PE in D
India under Article 5(2)(1) if it were to send some of its employees to India
as stewards or as deputationists in the employment of MSAS. Against this
ruling of the AAR the applicant and the Department have come to this Court
in appeal by way of special leave petition. According to the Department the
applicant should be regarded as having a fixed place in India under Article
5( l) as the applicant proposes to carry on its business through MSAS in E
India. According to the Department MSAS was the PE of the MSCo in India.
They had a fixed place of business in Mumbai. According to the Department
the nature of the activities proposed to be performed by MSAS in Mumbai
indicated that the said company represented the business presence of the
MSCo in India. The Department also submitted that MSAS was legally and F
financially dependent upon the applicant and consequently MSAS constituted
an agency PE of the applicant under Article 5(4) of the DTAA. Both these
contentions were rejected by the AAR vide the above impugned ruling.
However, it has been ruled by the AAR that MSAS should be regarded as
constituting a service PE under Article 5(2)(1) as it proposed to send its
employees to India for undertaking stewardship activities and for undertaking G
to send some of its employees to India as deputationists in the employment
of MSAS. It is against this ruling of the AAR that the applicant has come
to this Court by way of appeal. On the second question the AAR ruled that
the Transactional Net Margin Method (TNMM) was the most appropriate·
method for the determination of the Arm's Length Price (ALP) in respect of H
60
SUPREME COURT REPORTS
[2007] 8 S.C.R.
A the service agreement dated 14.4.2005 between the applicant and the MSAS
and as the said method meets the test of arm's length as prescribed under
Section 92-C of the 1961 Act, no further income was attributable in the hands
of MSAS in India. The said ruling of the AAR on the question of income
attributable to the PE is the subject matter of challenge by the Department.
B
EXISTENCE OF P.E. IN INDIA
6. With globalization, many economic activities spread over to several
tax jurisdiction. This is where the concept of P.E. becomes important under
Article 5(1). There exists a P.E. if there is a fixed place through which the
C business of an enterprise, which is multinational enterprise (MNE), is wholly
or partly carried on. In the present case MSCo is a multi-national entity. As
stated above it has outsourced some of its activities to MSAS in India. A
general definition of the P.E. in the first part of Article 5(1) postulates the
existence of a fixed place of business whereas the second part df Article 5( I)
postulates that the business of the MNE is carried out in India through such .
D fixed· place. One of the questions which we are called upon to decide is .
whether the activities to be undertaken by MSAS consists of back office
operations of the MSCo and if so whether such operations would fall within
the ambit of the expression "the place through which the business of an
enterprise is wholly or partly carried out" in Article 5(1 ).
E
7. We quote herein below Articles 5 and 7 of the DTAA:
F
G
H
"Article 5
PERMANENT ESTABLISHMENT
I.
For the purposes of this Convention, the term "permanent
establishment" means a fixed place of business through which
the business of an enterprise wholly or partly carried on.
2.
The term "permanent establishment" includes especially:
(a) a place of management; •
(b) a branch;
(c) an office;
( d) a factory;
\
7
DIT (INTERNATIONAL TAXATION). MUMBAI v. MORGAN STANLEY & CO. [KAPADIA, JJ
6}
(e) a workshop;
A
(t) a mine, an oil or gas well, a quarry or any other place of
extraction of natural resources;
(g) a warehouse, in relation to a person providing storage
facilities for others;
B
(h) a farm, plantation or other place where agriculture, forestry,
plantation or related activities are carried on;
\
(0 a store or premises used as a sales outlet;
(j) an installation or structure used for the exploration or c
exploitation of natural resources, but only if so used for a
period of more than 120 days in any twelve month period;
(k) a building site or construction, installation or assembly project
or supervisory activities in connection therewith, where such
site, project or activities (together with other such sites, D.
-
projects or activities, if any) continue for a period of more
than 120 days in any twelve month period;
0) the furnishing of services other than included services as
defined in Article 12 (Royalties and Fees for Included
Services), within Contracting State by an enterprise through E
employees or other personnel, but only if;
(i)
activities of that nature continue within that State for a
period or periods aggregating more than 90 within any
twelve-month period; or
F
(ii) the services are performed within that State for a related
enterprise (within the meaning of paragraph 1 of Article
9 (Associated Enterprise).
3.
Notwithstanding the preceding provisions of this Article, the
term "permanent establishment" shall be deemed not to include G
any one or more of the following :
(a) the use of facilities solely for the purpose of storage, display
or occasional delivery of goods or merchandise belonging to
the enterprise;
H
_,.,..
'
62
SUPREME COURT REPORTS
(2007) 8 S.C.R.
A
(b) the maintenance of a stock of goods or merchandise
belonging to the enterprise solely for the purpose of storage,
--...-
display, or occasional delivery;
(c) the maintenance of a stock of goods, or merchandise
belonging to the enterprise solely for the purpose of
B
processing by another enterprise;
·•
~
{d) the maintenance of a fixed place of business solely for the
t
purpose of purchasing goods or merchandise, or of collecting
~
information, for the enterprise;
c
(e) the maintenance of a fixed base of business solely for the
purpose of advertising, for the supply of information, for
..
scientific research, or for other activities which have
preparatory or auxiliary character, for the enterprise.
4.
Notwithstanding the provisions of paragraphs 1 and 2, where a
D
person other than an agent of an independent status to whom
paragraph 5 applies is acting in a Contracting State on behalf of
an enterprise of the other Contracting State other Contracting
State, that enterprise shall be deemed to have permanent
establishment in the first-mentioned State if:
E
(a) he has an habitually exercises in that first-mentioned State an
authority to conclude contracts on behalf of the enterprise, unless
his activities are limited to those mentioned in paragraph 3 which,
if exercised through a fixed place of business, would not make·
that fixed place of business, would not make that fixed place of
business a permanent establishment under the provisions of that
F
paragraph;
(b) he has no such authority but habitually maintains in the firstmentioned State a stock of goods or merchandise from which he
regularly delivers goods or merchandise on behalf of the
enterprise, and some additional activities conducted in that State
G
on behalf of the enterprise have contributed to the sale of the
goods or merchandise; or
(c) he habitually secures orders in the first-mentioned State,
wholly or almost wholly for the enterprise.
\
\
H
5.
An enterprise of a Contracting State shall not be deemed to have
OIT (INTERNATIONAL TAXATION), MUMBAI v. MORGAN STANLEY & CO. [KAPADIA, J.]
63
a pennanent establishment in the other Contracting State merely A
because it carries on business in that State through a broker,
general commission agent or any other agent of an independent
status, provided that such persons are acting in the ordinary
course of their business. However, when the activities.of such an
agent are devoted wholly or almost wholly on behalf of that B
enterprise and the transactions between the agent and the
enterprise and the transactions between the agent and the
enterprise are not made under ann's length conditions, he shall
\
not be considered an agent of independent status within the
meaning of this paragraph.
c
6.
The fact that a company which is a resident of a Contracting
State controls or is controlled by a company which is a resident
of the other Contracting State, or which carries on business in
that other State (whether through a pennanent establishment or
otherwise), shall not of itself constitute either company a
D
pennanent establishment of the other
'°"°°'
Article 7
BUSINESS PROFITS
E
l.
The profits of an enterprise of a Contracting State shall be taxable
only in that State unless the enterprise carries on business in the
other Contracting State through a permanent establishment
situated therein. If the enterprise carries on business as aforesaid,
the profits of the enterprise may be taxed in the other State but F
only so much of them as is attributable to (a) that permanent
establishment; (b) sales in the other State of goods or merchandise
of the same or similar kind as those sold through that permanent
establishment; or (c) other business activities carried on in the
other State of the same or similar kind as those effected through G
that permanent establishment.
2.
Subject to the provisions of paragraph 3, where an enterprise of
a Contracting State carries on business in the other Contracting
I
State through a permanent establishment situated therein, there
shall in each Contracting State be attributed to that permanent H
establishment the profits which it might be expected to make if
64
A
B
c
D
E
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G
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SUPREME COURT REPORTS
[2007] 8 S.C.R.
it were a distinct and independent enterprise engaged in the same
or similar activities under the same or similar conditions and
dealing wholly at arm's length with the enterprise of which it is
a permanent establishment and other enterprises controlling,
controlled by or subject to the same common control as the
enterprise, in any case where the correct amount of profits
attributable to a permanent establishment is incapable of
determination or the determination thereof presents exceptional
difficulties, the profits attributable to the permanent establishment
./
may be estimated on a reasonable basis. The estimate adopted
shall, however, be such that the result shall be in accordance with
the principles contained in this Article.
3.
In the determination of the profits of a permanent establishment,
there shall be allowed as deductions expenses which ~re incurred
for the purposes of the business of the permanent establishment,
including a reasonable allocation of executive and general
administrative expenses, research and development expenses,
interest and other expenses, incurred for the purposes of the
enterprise as a whole (or the part thereof which includes the
permanent establishment), whether incurred in the State in which
the permanent establishment is situated or elsewhere, in
accordance with the provisions of and subject to the limitations
of the taxation laws of that State. However, no such deduction
shall be allowed in respect of amounts, if any, paid (otherwise
than towards reimbursement of actual expenses) by the permanent
establishment to the head office of the enterprise or any of its
other offices, by way of royalties, fees or other similar payments
in return for the use of patents, know-how or other rights, or by
way of commission or other charges for specific services
performed or for management, or except in the case of banking
enterprise, by way of interest on moneys lent to the permanent
establishment. Likewise, no account shall be taken, in the
determination of the profits of a permanent establishment, for
'.'!mounts charged (otherwise than toward reimbursement of actual
expenses), by the permanent establishment to the head office of
the enterprise or any of its other offices, by way of royalties, fees
or other similar payments in return for the use of patents, knowhow or other rights, or by way· of commission or other charges
f •
r-
,
I-
\
n
~
~
~
,i.
~·
I
DIT (INTERNATIONAL TAXATION), MUMBAI •·.MORGAN STANLEY & CO [KAPADIA, l.]
65
for specific services performed or for management, or, except in A
the case of a banking enterprise, by way of interest on moneys
lent to the head office of the enterprise or any of its other offices.
4.
No profits shall be attributed to a permanent establishment by
reason of the mere purchase by that permanent establishment of
goods or merchandise for the enterprise.
5.
For the purposes of this Convention, the profits to be attributed
to the permanent establishment as provided in paragraph I (a) of
this Article shall include only the profits derived from the assets
B
and activities of the permanent establishment and shall be
determined by the same method year by year unless there is C
good and sufficient reason to the contrary.
6.
Where profits include items of income which are dealt with
separately in other Articles of the Convention, then the provisions
of those Articles shall not be affected by the provisions of this
Article.
D
7.
For the purposes of the Convention, the term "business profits"
means income derived from any trade or business including income
from the furnishing of services other than included services as
defined in Article 12 (Royalties and Fees for Included Services)
and including income from the rental of tangible personal property E
other than property described in paragraph 3 (b) of Article 12
(Royalties and Fees for Included Services)."
8. In our view, the second requirement of Article 5(1) of DTAA is not
satisfied as regards back office functions. We have examined the terms of the
Agreement along with the advance ruling application made by MSCo inviting F
the AAR to give its ruling. It is clear from reading of the above Agreement
/application that MSAS in India would be engaged in supporting the front
office functions ofMSCo in fixed income and equity research and in providing
IT enabled services such as data processing support centre and technical
services as also reconciliation of accounts. In order to decide whether a P.E.
stood constituted one has to undertake what is called as a functional and G
factual analysis of each of the activities to be undertaken by an establishment.
It is from that point of view, we are in agreement with the ruling of the AAR
/
that in the present case Article 5(1) is not applicable as the said MSAS would
be perf onning in India only back office operations. Therefore to the extent of
the above back office functions the second part of Article 5( I) is not attracted. H
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[2007) 8 S.C.R.
A
9. Lastly, as rightly held by the AAR there is no agency PE as the PE
in India had no authority to enter into or conclude the contracts. The contracts
would be entered in the United States. They would be concluded in US. The
implementation of those contracts only to the extent of back office functions
would be carried out in India, and therefore, MSAS would not constitute an
B Agency PE as contended on behalf of the Department.
10. In the DTAA, the term P.E. means a fixed place of business through
which the business of an MNE is wholly or partly carried out. The definition
of the word P.E. in Section 92(F)(iii) is inclusive, however it is not under
1
Article 5(1) of the Treaty. It is for this reason that Article 5(2) of the DT AA
C herein refers to places included as P.E. of the MNE. One such place is
mentioned in Article 5(2)(1) which deals with furnishing of services.
11. The concept of P.E. was introduced in 1961 Act as part of the
statutory provisions of transfer pricing by the Finance Act of 200 l. In Section
92-F (iii) the word "enterprise" is defined to mean "a person including a P.E.
D of such person who is proposed to be engaged in any activity relating to the
production ... "Under the CBDT circular No.14 of2001 it has been clarified that
the term P.E. has not been defined in the Act but its meaning may be
untferstood with reference to the DT AA entered into by India. Thus the ·
intention was to rely on the concept and definition of P.E. in the DTAA.
However, vide Finance Act, 2002 the definition of P.E. was inserted in the
E Income Tax Act, 1961 (for short, 'LT. Act') vide Section 92-F (iiia) which states
that the P.E. shall include a fixed place of business through which the
business of the MNE is wholly or partly carried on. This is where the
difference lies between the definition of the word P.E. in the inclusive sense
under the I. T. Act as against the definition of the word P.E. in the exhaustive
p
sense under the DT AA. This analysis is important because it indicates the
intention of the Parliament in adopting an inclusive definition of P.E. so as
to cover service P.E., agency P.E., software P.E., Construction PE etc.
12. There is one more aspect which needs to be discussed namely,
exclusion of P.E under Article 5(3). Under Article 5(3) (e) activities which are
G preparatory or auxiliary in character which are carried out at a fixed place of
business will not constitute a P.E. Article 5(3) commences with a non obstante
clause. It states that notwithstanding what is stated in Article 5(1) or under
f
Article 5(2) the tenn P.E. shall not include maintenance of a fixed place of
\
business solely for advertisement, scientific research or for activities which
H are preparatory or auxiliary in character. In the present case we are of the view
·.
DIT (INTERNATIONAL TAXATION), MUMBAI v. MORGAN STANLEY & CO. [KAPADIA, l.)
67
that the above mentioned back office functions proposed to be performed by A
MSAS in India falls under Article 5(3 )( e) of the DT AA. Therefore, in our view
in the present case MSAS would not constitute a fixed place P.E. under
Article 5(1) of the DTAA as regards its back office operatwns.
13. However, the question which arises for determination in the present
case is the nature of activities performed by stewards and deputationists B
deployed by MSCo to work in India as employees of MSAS. Under Article
5(2)(1) furnishing of services through the fixed place in India can constitute
a P.E. The AAR in the impugned ruling has held that the stewards and
deputationists are proposed to be sent by the MSCo from U.S. According to
the AAR there is a flow of service from the MSCo to the MSAS when the C
former deputes its own employees to work in India in MSAS. Therefore,
according to the AAR the service Agreement between MSCo and MSAS
dated 14.4.2005 would fall under Article 5(2)(1) and consequently the transfer
pricing regulation would apply for evaluating the charges payable by MSCo
to MSAS in India for such service contract. This ruling has been challenged
by the applicant.
D
14. Article 5(2XI) of the DTAA applies in cases where the MNE furnishes
services within India and those services are furnished through its employees.
In the present case we are concerned with two activities namely stewardship
activities and the work to be performed by deputationists in India as employees
of MSAS. A customer like an MSCo who has world wide operations is E
entitled to insist on quality control and confidentiality from the service provider.
For example in the case of software P.E. a server stores the data which may
require confidentiality. A service provider may also be required to act according
to the quality control specifications imposed by its customer. It may be.
required to maintain confidentiality. Stewardship activities involve briefing of F
the MSAS staff to ensure that the output meets the requirements of the
MSCo. These activities include monitoring of the outsourcing operations at
MSAS. The object is to protect the interest of the MSCo. These stewards are
not involved in day to day management or in any specific services to be
undertaken by MSAS. The stewardship activ.ity is basically to protect the
interest of the customer. In the present case as held hereinabove the MSAS G
is a service P.E. It is in a sense a service provider. A customer is entitled to
protect its interest both in terms of confidentiality and in terms of quality
control. In such a case it cannot be said that MSCo has been rendering the
services to MSAS. In our view MSCo is merely protecting its own interests
in the competitive world by ensuring the quality and confidentiality of MSAS H
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[2007) 8 S.C.R.
A services. We do not agree with the ruling of the AAR that the stewardship
activity would fall under Article 5(2)(1). To this extent we find merit in the civil
appeal filed by the appellant (MSCo) and accordingly its appeal to that extent
stands partly allowed.
15. As regards the question of deputation, we are of the view that an
B employee of MSCo when deputed to MSAS does not become an employee
ofMSAS. A deputationist has a lien on his employmentwith MSCo.